Housing market playing a big role in Fed's inflation fight

The housing sector could be the key for the Federal Reserve's campaign to tame inflation down to its 2% target rate, which Fed Chair Jerome Powell characterized as being on a "sometimes bumpy path."

Yahoo Finance Head of News Myles Udland joins the Morning Brief to break down home prices' pivotal role in CPI (consumer price index) and PCE (personal consumption expenditures index) inflation data and how Fed officials are considering the housing market while balancing its inflation-labor market dual market.

For more expert insight and the latest market action, click here to watch this full episode of Morning Brief.

Editor's note: This article was written by Luke Carberry Mogan.

Video Transcript

- Housing playing an outsized role in the Fed's challenge to bring down inflation. There's a Wells Fargo report out that took a deep dive into the gap that we've seen between core PCE and core CPI. Here to explain, Yahoo Finance's Myles Udland. Myles, you wrote about this in our morning brief earlier this week. Just talk to us about the discrepancy that we're seeing and this outsized role as you put it that housing is now playing in the Fed's fight to tame inflation.

MYLES UDLAND: Yeah. So if we look at that first chart of the gap between core PCE and core CPI, 1% point is the gap right now. Historically, the gap's has been about 3/10% PCE on the lower side. So CPI in general, has been a little bit higher, hotter, however you want to say it but by a significantly-- by a significantly smaller margin than we currently see.

Now everybody knows housing costs are a big driver of inflation overall. The BLS called out in its last CPI report that housing costs were over 2/3 of the annual increase in CPI we saw and that's really creating this problem for the Fed where core CPI is still at 3.8%, almost double their target.

Now core PCE is running at 2.8% year over year, above the 2% target but closer to there. And if we saw that chart where you see the share that housing plays in each measure, over 40% of core CPI is housing costs, up 5.9% year over year. Just 17.5% of PCE is housing costs, which are up 5.8% a year in that measurement.

And so while the Fed cares about PCE and they will say they're focused on that measure, it's going to be challenging. And I mean, it is challenging at this point for the Fed to make this argument for needing to cut rates with the more popular inflation measure, CPI, still at 3.8%, even when, you know, trimmed down for the Fed's preferred way to look at it.

So they are confident-- everyone's confident, housing costs, it's kind of a lag, yada-yada. We've been through the whole rent story, all this, that, the other. But that gap is a major challenge. That measurement issue is a major challenge for the Fed and trying to communicate why they need to cut rates.

BRAD SMITH: Yeah, you mentioned rent. There was a study out. I think it was published this morning by Apartment.com. National average annual asking rent rose by about 7/10% in March compared to 8/10% the prior two months. So that's still going higher. This entire housing picture though, how much can the Fed-- what levers can they really pull to influence it in the near term?

MYLES UDLAND: Well, it's interesting because I wrote-- so I wrote this earlier this week-- two weeks ago I wrote how the Fed does not care about the housing market because Powell also said that at his press conference back in January where he was asked explicitly that question. And he said we don't target housing policy, or any rate of housing inflation, or anything like this.

And so the Fed wants to walk this very narrow path of, it has a dual mandate to look at inflation, to look at employment, and things that are related to that, of which obviously housing wages are parts of it. They will accept and they will tell you point blank that's not something that we know we can control. They obviously monitor it but what housing prices do, what the stock market does is not necessarily going to be a motivator to Powell.

- And how much is it-- real quick because we only have 30 seconds, but it's not just housing, right? And you pointed that out when you take a look at some of the other data points that we've gotten out, specifically manufacturing data like you referenced in your piece showing that inflation, they're battling a lot of battles.

MYLES UDLAND: So the problem with inflation, and we do not have 30 seconds to do this, but Brad referenced it, right? We are on a huge lag for apartment rents specifically being the main driver here. Everyone's been waiting for them to bring down overall inflation.

In that interim period, the economy has accelerated as we talk about on this show every day and that's bringing in this risk of while housing comes to where you want it to be for the Fed to meet its goal, other parts of the economy get on firmer footing and inflation reaccelerates. Again, good for growth. People are happy with that. But for a Fed trying to get inflation all the way back to 2%, it's a major hurdle.

- All right, Myles, always great to have you on set.

BRAD SMITH: That was 30 seconds by the way.

MYLES UDLAND: I mean, I think 5,730 is where we need to get out. So we're all right.